Gran Tierra Energy (GTE-T) On sale for half price
[ Peter Imhof, AGF Investments likes GTE-T (comfort holding) on BNN.ca Market Call Wednesday Nov 26 @ 1300ET ]
(Editor's Note: Investors should be mindful of the risks of transacting in securities with limited liquidity, such as Gran Tierra's U.S. listing. The company's Toronto listing, GTE.TO, offers somewhat stronger liquidity.)
Gran Tierra Energy is an oil and gas E&P company headquartered in Canada and incorporated in the US with production and assets located in South America. The company has fallen from a 52-week high of $8.18 set in June to close Monday at $4.76 (down 40%). Was the drop justified or does the company now represent good value? I'll take a look at the company's production profile, analyze the most recent EPS report, evaluate the company's reserves, and look for catalysts that could move the stock. But first, I will present a broad overview of the company.
Company Overview(click to enlarge) 
Source: September presentation (available here)
Significantly, Gran Tierra has no debt and is sitting on a pile of cash ($360 million at the end of Q3). With 288 million diluted shares outstanding, the company has ~$1.25 per share of cash and cash equivalents. Not bad for a company trading at only ~$4.76/share. No wonder directors and officers own 5.7% of the company.
In addition, the company has strong cash flow from continuing operations. For the 9-months YTD, GTE had FFO of $261 million and posted net income of $0.35/share.
Now let's take a closer look at the company's production profile, Q3 EPS, and the 2013 year-end reserves report.
Production ProfileThe latest 3-month and 9-month production profiles are shown below and come from GTE's Q3 earnings report:
(click to enlarge) 
Observations:
Q3 total production of 20,641 boe/d (net) was up +7.1% yoy.Nine-month YTD production was down -2.6%.YTD, Colombian production was 95% of total production.YTD, Brazil production is up +24% yet is only 5% of total production.Note the effect of net after royalty ("NAR") payments. YTD, Gran Tierra has paid ~25% of production for royalties in Colombia and 13.6% in Brazil.
From the EPS report, GTE reports that 99% of production is oil with the rest being natural gas.
EarningsThree and nine-month EPS results are shown below:
(click to enlarge) 
Observations:
3 and 9-month revenues were down -5% and -9% yoy, respectively.9-month net income of $0.35/share was down -29% yoy.For Q3, losses from discontinued operations negatively affected year earlier results, which made yoy comparisons easy to beat.For 9-month YTD results, discontinued operations accounted for a net loss of $27 million, or $0.09/share.Fund flows from continuing operations (shown below) have remained relatively flat throughout 2014.
(click to enlarge) 
Assets & ReservesAccording to GTE's 2013 year-end reserves report, the company has a total of 42,088,000 boe of proven NAR reserves, of which 94.7% is liquids and the rest gas (note gas reserves are listed in MMcf, not boe). Also, realize the chart shown below is SEC compliant (US) as opposed to Canadian compliant reserves reporting.
Reading on in the reserves report we discovery that:
Total NAR proved reserves, after 2013 yearly production, grew only 4%.Total proved plus probable ("2P") reserves effectively doubled, largely due to the Bretaña field in Block 95 in Peru.3P reserves also effectively doubled yoy.ColombiaTotal NAR proven reserves in Colombia equate to 85.6% of GTE's total. Colombian reserves are defined by two fields: the Costayaco (20,194 Mboe) and Moqueta (10,021 Mboe). From these figures, we can deduce that the Costayaco field represents ~50% of GTE's total NAR proved reserves. As pointed out earlier, together these two fields in Colombia accounted for ~95% of total YTD production.
BrazilBrazil accounted for only 5% of Q3 NAR production. On a proved NAR reserves basis, Brazil equates to only 4%, and 3P reserves are only 2.5% of GTE's total. This all leads me to wonder why, if GTE sold its assets in Argentina (see below) to focus on Colombia and Peru, why does it not jettison the Brazilian assets as well? While the royalty payments in Brazil are almost half that of Colombia, the bottom line is that production and prospective reserves are marginal at best and should be monetized. On a flowing boe and reserves basis, a read-across from the Argentina deal indicates GTE should be able to sell its Brazilian assets for $30-40 million.
PeruWhile GTE has no production and no booked reserves in Peru, the company's leasehold in the country is a platform for significant future growth and a positive catalyst. Note that 3P reserves of 104.7 million boe are liquids and represent ~57% of total company 3P reserves.
Looking at the reserves' NAR proportions, Peru is expected to exact an ~8% share of production (using 3P numbers). This compares to 15.3% for the company's total 3P reserves. The point is that more of Peru's future production will drop to the bottom line as compared to Colombia and Brazil.
ArgentinaThe 2013 year-end reserves report included proved reserves of 3,604,000 boe of oil and 4,677,000 MMcf of gas from Argentina. However, GTE closed the sale of its assets in Argentina to Madalena Energy (OTCPK:MDLNF) for $49 million in cash, $14 million worth of Madalena shares, and working capital adjustments of $6 million - a total consideration of ~$69 million. The Argentine business unit contributed an average daily production of 1,365 boe/day in 2014 and is now considered discontinued operations and thus absent from the production profile chart shown at the top of the article. As a result of the sale, GTE reduced its 2014 cap-ex plan by $48 million less the amount spent YTD prior to the sale. Management said the sale will allow the company to focus on exploration and development of the company's assets in Colombia and Peru.
Upside PotentialGTE's solid production and cash flow from its core operations in Colombia will enable the company to begin exploration, development, and exploitation of the huge resource potential its Peruvian leasehold offers. And that is exactly what the company is doing. In the Q3 EPS report, GTE announced it had cut the 2014 capital budget by $10 million to $472 million as a result of the sale of its Argentina assets. The budget will now be spread out as follows:
2014 Capital Budget
| Colombia | $248 million | | Peru | $175 million | | Brazil | $26 million | Argentina (discontinued)
| $18 million | | Corp. Activities | $5 million |
The capital expenditure program allocates:
$286 million for drilling.$65 million for facilities, pipelines and other.$116 million for geological and geophysical expenditures.Of the $286 million allocated to drilling, ~17% is for exploration and the balance is for appraisal and development drilling. The budget plans for drilling of 11 gross wells in Colombia and two gross wells in Peru.
(click to enlarge) 
As the slide above indicates, GTE has 5.7 million gross acres in Peru. I have highlighted Block 95 because it is home to the Bretana discovery - a near-term growth catalyst.
BretanaGTE has a 100% working interest in Block 95 and is the operator. The Bretana Norte 95-2-1XD well encountered an excellent 53-foot net column of pay. A horizontal sidetrack had a natural flow rate of 3,095 bpd of 18.5 degree API oil.
Rig mobilization for the new Bretaña Sur appraisal well has begun and the well is expected to be drilled in December 2014. The well will gather additional reservoir data and is expected to further substantiate oil reserves in the field.
The company will also drill its first long-term test ("LTT") well during Q4. It expects the well to flow at 2,500 bpd (gross) and to be brought into production before year-end. Subject to front end engineering and design, the company expects to bring on production of 6,000 bpd by 2017, with a plateau of 20-40,000 bpd in the 2021 timeframe. GTE believes the reservoir structure has three additional exploration prospects.
An SEC compliant third party reserves study by GLJ Consultants reported Bretana 3P reserves potential at over 100 million barrels of oil:
In addition to Bretana, GTE's leasehold on Blocks 107 and 133 in Peru are highly prospective and on-trend with some adjacent prolific discoveries including the Los Angeles-1 discovery. The Osheki play in block 107 has a P50 resource potential of 250 million barrels and is considered a medium-term catalyst.
(click to enlarge) 
In the longer term (2016+), the company plans to begin drilling in blocks 123 and 129 where it has identified 13 new prospects in the Cacique and Saltarin-Harpia plays. The total P50 best estimate for these two plays' resource potential is over 600 million barrels.
But back to Bretana - the near-term catalyst.
According to a previous GTE press release, Bretana holds 2P reserves potential of 61.5 million barrels of oil and 3P reserves of 113.9 million barrels of oil. The pre-tax NPV10 of Bretana's 2P reserves (SEC compliant) is ~$624 million, while the pre-tax NPV10 of the 3P reserves is ~$1.495 billion.
With 288 million shares outstanding and at the close of trading yesterday ($4.76 on the NYSE), GTE currently has a market cap of $1.37 billion. At the end of Q3, the company had $360 million in cash and no debt. That means the company's assets - including 42,088,000 boe of proven NAR reserves (99% oil) and estimated 2014 average production of 19,300 bpd, are valued at only ~$1 billion. Even at an oil price of $70/barrel, the current proved NAR reserves alone represent $2.9 billion in revenue. If we deduct 50% for development costs, we get $1.45 billion - 45% higher than today's valuation and this neglects the fact that the company already has over 19,000 bpd of production (mostly Colombian) online, where GTE has proven its ability to exploit those assets.
Bottom line: after the recent dramatic drop in the stock price of GTE, you can make a good case that GTE is undervalued by 40-50% with respect to its reserves, production, and EPS relative to its Colombian assets alone. (Coincidentally, that is about the amount the stock has dropped from its high). If we add in the 2P NPV10 of the Bretana field in Brazil ($624 million), where an existing discovery is evidence of a prolific reservoir structure where production should commence in Q4, we get a quite conservative estimated valuation of $1.45 billion (Colombia) + $635 million (2P NPV10 Peru) = ~$2 billion. If we take into account the company's current cash position, this suggests the company is trading at about half its intrinsic value. And remember, this estimate neglects a couple of important variables:
Reserve additions due to 2014's drilling campaign.Other very prospective medium and longer-term plays in Peru besides Bretana.So to answer the question I began this article with, "Was the drop justified or does the stock represent good value?", the answer is a resounding YES - GTE currently represents excellent value.
While my estimated value of GTE suggests the stock is undervalued by half, we must temper this enthusiasm with the reality that energy stocks are currently out of favor, that oil prices have contracted to a relatively low-level range of $75-80/barrel, and that oil could fall further unless the world economy picks up and demand rises, or, OPEC cuts production, or both. In such an environment, it seems prudent to trim my expectation for the stock to double in half, or for a 50% gain. That said, if drilling results in Peru indicate a substantial increase in proven reserves and production, I would raise the PT to a 75% gain over the next 12 months. For now, we'll go with expectations for a 50% gain.
RisksOne risk, of course, is continued weakness in oil prices. Add to that the political risks (real or imagined) associated with operating in South American countries like Colombia and Peru. That said, a Canadian company like GTE is likely viewed as a more friendly partner in South America than would be a US company. The United States is viewed by many South American countries in a negative light due to the perception (right or wrong) of decades of political and military interference. From this angle, a Canadian company is likely at an advantage.
A more relevant, real, and near-term risk involves transport of the company's production in Colombia. From the Q3 EPS report we learned that one reason for a 12% reduction in realized prices (to $84.50/bbl) was a disruption to the Ecopetrol (EC-NY) operated Trans-Andean oil pipeline (the "OTA" pipeline). As a result, 62% of GTE's oil volumes during the quarter were sold to non-EC customers. The result was a $7.61/bbl reduction in realized prices. Also, beginning July 1, 2014, the port operations fee component of the OTA pipeline pricing structure increased by $2.94 per bbl resulting in a reduction of realized oil prices by this amount on sales delivered through the OTA pipeline. Production during the three months ended September 30, 2014, reflected approximately 63 days of oil delivery restrictions in Colombia compared with 35 days, respectively, of oil delivery restrictions in Q3 of 2013. As a result, on a per BOE basis, operating expenses increased in Q3 by 26% to $17.88 from $14.14 in the Q3 of 2013 - primarily as a result of higher pipeline and trucking costs due to sales to alternative customers with delivery points, which carried high transportation costs, and increased workover expenses.
As opposed to sabotage, the OTA outage in July was caused by a landslide. The pipeline, operated by Ecopetrol - Colombia's state oil company - runs through Bolivia, Colombia, Ecuador and Peru. The OTA has been sometimes attacked by guerrillas and has suffered unscheduled shutdowns. Any shutdown of the OTA can directly affect Gran Tierra's production, inventory levels, and realized prices.
While the pipeline is reportedly back up and running, the higher per barrel tariff on a barrel of oil (up nearly $3/bbl) will be a headwind going forward when it comes to yoy EPS comparisons. For example, on Q3 average production of 19,637 bpd from Colombia, assuming all of it was transported through the pipeline, the new fee would exact a ~$59,000/day hit on earnings, or ~$5.3 million for the entire quarter. That equates to a 1.8 cent/share hit to EPS. While that is certainly material for a stock with $0.15/share of quarterly earnings, it equates to only 12% and of and by itself does not substantiate the 40% sell-off in the stock since July.
GTE does not pay a dividend. As such, there is no yield related downside protection.
Summary & ConclusionGran Tierra Energy is a Canadian company with operations in South America. It has core assets and production in Colombia that are solidly profitable and throw off cash flow that can be used to explore and develop highly prospective acreage in Peru - where the company has a very large leasehold and one prolific discovery. The company has $360 million in cash (~$1.25/share), no debt, and closed trading yesterday at $4.76/share on the NYSE with a trailing twelve-month P/E = 14.7 (source: TMX money). While my conservative valuation estimate indicates the company is undervalued by half, and investors get the highly prospective assets in Peru for free, due to the current weakness in oil prices and the fact that the energy sector is out-of-favor (to put it mildly), I will put a 12-month price target on GTE of $7.50. Note that due to the stock's severe sell-off this year, my $7.50 price target (which implies a 50% upside) is still below the stock's 52-week high set back in June of $8+. I believe the stock has put in a bottom after the wicked (and somewhat unjustified) sell-off. The downside appears limited to $4.50 (see chart below).
Another positive catalyst would be an announcement that GTE intends to sell, or has sold, its Brazilian assets - which account for only marginal production and could fetch $30-$40 million. If so, the company could focus only on its core assets in Colombia and Peru.
While Gran Tierra is not for the faint-of-heart, and investors should by no means "bet the ranch," the company represents an excellent risk/reward potential for that (small) portion of an investor's portfolio looking for outsized gains. If GTE's wells in Peru come in as expected, or better, this stock could easily be a multi-bagger over the next 2-3 years. Gran Tierra Energy is a BUY. |
